Supreme Court clarifies Service Tax on Chit Funds: Union of India vs. Margadarshi Chit Funds (2017)

Introduction

Date of the Judgment: July 4, 2017
Citation: [Not Available in Source]
Judges: A.K. Sikri, J. and R.K. Agrawal, J. (authored by A.K. Sikri, J.)

Are chit funds a form of ‘cash management’ and therefore subject to service tax? The Supreme Court of India recently addressed this complex question, examining whether the activities of chit funds fall under the ambit of ‘banking and other financial services’ as defined in the Finance Act, 1994. This judgment clarifies the applicability of service tax on chit fund operations, particularly in light of amendments made in 2007.

Case Background

The dispute arose after the Finance Act, 2007 amended the definition of ‘banking and other financial services’ by removing the exclusion of ‘cash management.’ The Revenue Department then issued circulars stating that chit funds, being a form of cash management, were now subject to service tax. Several chit fund companies challenged these circulars, arguing that their activities did not constitute ‘asset management’ as required under the amended definition. The High Court of Judicature at Andhra Pradesh sided with the chit fund companies, leading to the Union of India appealing to the Supreme Court.

Timeline

Legal Framework

The core of this case revolves around the interpretation of ‘banking and other financial services’ under Section 65(12) of the Finance Act, 1994. The definition, prior to June 1, 2007, included asset management but specifically excluded cash management. The Finance Act, 2007 amended this definition by deleting the exclusion of cash management. The court also considered the Chit Funds Act, 1982, which defines ‘chit’ as a transaction where subscribers contribute to a fund, with the prize amount distributed periodically. Key provisions include:

• Section 65(12) of the Finance Act, 1994: Defines ‘banking and other financial services.’ Before the 2007 amendment, it included asset management but excluded cash management. After the amendment, the exclusion of cash management was removed.
• Section 2(b) of the Chit Funds Act, 1982: Defines ‘chit’ as a transaction where subscribers contribute to a fund, with the prize amount distributed periodically.
• Section 45-I of the Reserve Bank of India Act, 1934: Categorizes chit funds as financial institutions.

The court also noted that the Finance Act, 2012 introduced a negative list of services, fundamentally changing the service tax regime. This new system defines ‘service’ and lists exclusions, moving away from the previous list of taxable services.

Arguments

Arguments by the Union of India:

• The Union of India argued that the business of chit funds was always understood to be in the nature of cash management.
• Since the definition of ‘banking and financial services’ prior to June 1, 2007, specifically excluded ‘cash management’, the benefit was extended to chit fund companies by not levying any service tax.
• With the amendment, the exclusion of ‘cash management’ was removed, bringing chit fund companies within the purview of service tax.
• Sub-clause (v) of sub-section (12) specifically covers ‘asset management’ as ‘banking and other financial services’ and mentions that ‘all forms of fund management’ are to be treated as ‘asset management’.
• Cash management is one of the forms of ‘fund management’.

Arguments by the Chit Fund Companies:

• The chit fund companies contended that the chit fund business does not amount to any service covered by the definition of ‘banking and other financial services’.
• They argued that the mere deletion of the words ‘but does not include cash management’ would not suffice to bring chit funds under service tax.
• For the purpose of coverage, it is necessary that the business of chit fund is that of ‘asset management’, which it is not.
• They emphasized that there was no specific definition of ‘cash management’ or ‘asset management’ in the Act.
• They argued that taxing statutes must be interpreted strictly, and if two views are possible, the benefit of doubt should be given to the assessee.

Submissions Table

Innovativeness of the argument: The Union of India’s argument was innovative in that it attempted to bring chit funds under the ambit of service tax by linking it to ‘cash management’ and then to ‘fund management’. This was a novel interpretation of the amended provisions.

Issues Framed by the Supreme Court

The Supreme Court framed the following key issues for consideration:

1. Whether chit fund activity can be treated as the business of cash management?
2. Whether chit fund can be treated as a form of fund management?

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Supreme Court considered the following authorities:

Cases

• Sriram Chits and Investment (P) Ltd. v. Union of India [AIR 1993 SC 2063] – Supreme Court: This case was cited to explain the nature of chit fund business. The court reiterated that a chit fund transaction is not a case of borrowing or lending but a special form of contract. The foreman acts as a facilitator and not a lender.
• Reserve Bank of India v. Pearless General Finance and Investment Company Limited [AIR 1987 SC 1203] – Supreme Court: This case was cited to highlight the two types of chits: simple and business chits.
• Union of India & Ors. v. Martin Lottery Agencies Limited [(2009) 12 SCC 209] – Supreme Court: The Court referred to this case to emphasize that the dictionary meaning of a term may not always be appropriate in legal interpretation.
• Commissioner of Income Tax (Central)-I, New Delhi v. Vatika Township Private Limited [(2015) 1 SCC 1] – Supreme Court: This case was cited to highlight that taxing statutes must be specific and certain, and any ambiguity must be resolved in favor of the assessee.
• Commissioner of Income Tax, Patiala & Ors. v. Shahzada Nand & Sons & Ors. [(1966) 3 SCR 379] – Supreme Court: The court cited this case to emphasize the rule of strict interpretation for taxing statutes.
• All Kerala Association of Chit Funds v. Union of India [2013 (29) STR 557] – Kerala High Court: This case was discussed and overruled. The Kerala High Court had held that cash management is a form of fund management and therefore, chit funds are covered under ‘asset management’.
• Delhi Chit Fund Association v. Union of India [2013 (30) STR 347 (Del)] – Delhi High Court: This case was discussed and the view of the Delhi High Court that chit fund business was not exigible to service tax was upheld.

Books

• Corporate Finance by Aswath Damodaran: This book was referred to for understanding the concept of cash management in business.
• Advanced Law Lexicon, Book I, P. Ramanatha Aiyar, 3rd edition Reprint 2009: This book was referred to for the definition of ‘fund management’ and ‘asset management’.

Legal Provisions

• Section 65(12) of the Finance Act, 1994: The definition of ‘banking and other financial services’ was central to the case.
• Section 2(b) of the Chit Funds Act, 1982: This section defines ‘chit’.
• Section 45-I of the Reserve Bank of India Act, 1934: This section categorizes chit funds as financial institutions.
• Section 65B(44) of the Finance Act, 1994: Definition of “service” after the 2012 amendment.

Authority Consideration Table

Judgment

The Supreme Court, after considering the arguments and authorities, concluded that chit fund activities do not fall under ‘banking and other financial services’ for the purpose of service tax.

Treatment of Submissions

View of Authorities

• Sriram Chits and Investment (P) Ltd. v. Union of India [AIR 1993 SC 2063]*: The court relied on this case to understand the nature of chit fund business as a special contract, not a lending activity.
• Reserve Bank of India v. Pearless General Finance and Investment Company Limited [AIR 1987 SC 1203]*: The court used this case to distinguish between simple and business chits.
• Union of India & Ors. v. Martin Lottery Agencies Limited [(2009) 12 SCC 209]*: The court cited this case to caution against relying solely on dictionary meanings for legal terms.
• Commissioner of Income Tax (Central)-I, New Delhi v. Vatika Township Private Limited [(2015) 1 SCC 1]*: The court applied the principle that taxing statutes must be specific and certain, and any ambiguity should favor the assessee.
• Commissioner of Income Tax, Patiala & Ors. v. Shahzada Nand & Sons & Ors. [(1966) 3 SCR 379]*: The court reiterated the rule of strict interpretation for taxing statutes.
• All Kerala Association of Chit Funds v. Union of India [2013 (29) STR 557]*: The court overruled this judgment, disagreeing with its view that chit funds are covered under ‘asset management’.
• Delhi Chit Fund Association v. Union of India [2013 (30) STR 347 (Del)]*: The court upheld the view of the Delhi High Court that chit fund business is not exigible to service tax.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following factors:

• Strict Interpretation of Taxing Statutes: The court emphasized that taxing statutes must be interpreted strictly, and any ambiguity should favor the assessee. This principle was crucial in determining that the definition of ‘banking and other financial services’ did not clearly include chit fund activities.
• Nature of Chit Fund Business: The court analyzed the nature of chit fund operations, concluding that they do not constitute ‘cash management’ or ‘fund management’ as understood in business and financial contexts.
• Lack of Specific Definition: The absence of a specific definition for ‘cash management’ in the Finance Act, 1994, further weighed against the Revenue’s claim.
• RBI’s Opinion: The court considered the RBI’s opinion that chit fund business does not fall under fund or cash management.

Sentiment Analysis Ranking

Fact:Law Ratio

Logical Reasoning

The court considered the argument that the deletion of the words ‘but does not include cash management’ from the definition of ‘banking and other financial services’ in 2007 would bring chit funds under the ambit of service tax. However, the court rejected this argument, stating that the deletion alone is not sufficient to include chit fund activities under service tax. The court also considered that the definition of ‘asset management’ includes ‘all forms of fund management’. However, the court held that chit fund activities do not fall under the category of ‘fund management’. The court also rejected the argument that cash management is a form of fund management.

The court emphasized that taxing statutes must be interpreted strictly, and any ambiguity should favor the assessee. The court also noted that the RBI had clarified that chit funds do not fall under fund or cash management. The court also considered the dictionary meaning of ‘cash management’ and ‘fund management’ and held that chit fund activities do not fall under either of these categories.

The court quoted from the judgment:

“In a Taxing Act one has to look merely at what is clearly said. There is no room for any intendment. There is no equity about a tax. There is no presumption as to a tax. Nothing is to be read in, nothing is to be implied. One can only look fairly at the language used.”

“The dominant purpose of the Act is to regulate the chit and control the activity of the foreman and protect the interests of the subscribers. The pith and substance of the Act is that it provides for a special contract.”

“Cash management, thus, deals with optimisation of cash as an asset and for this purpose various decisions are to be taken for proper management thereof. The cash management schemes are, thus, built around two goals: (a) to provide cash needed to meet the obligations and (b) to minimise the idle cash held by the business.”

There was no minority opinion in this case. The judgment was authored by A.K. Sikri, J. and R.K. Agrawal, J. concurred with the same.

Key Takeaways

The key practical implications of this judgment are:

• No Service Tax on Chit Funds (2007-2012): Chit fund companies were not liable for service tax on their activities between June 1, 2007, and June 30, 2012, under the category of ‘banking and other financial services’.
• Clarity on ‘Cash Management’: The judgment provides clarity on the definition of ‘cash management’ and its distinction from chit fund operations.
• Strict Interpretation of Tax Laws: The judgment reinforces the principle that tax laws must be interpreted strictly, and any ambiguity should favor the assessee.
• Overruling of Kerala High Court: The Kerala High Court’s view that chit funds are covered under ‘asset management’ was expressly overruled.

The judgment has a significant impact on the service tax regime and provides much-needed clarity for chit fund companies. It also underscores the importance of precise language in tax laws and the need for strict interpretation.

Directions

No specific directions were given by the Supreme Court in this judgment.

Specific Amendments Analysis

The judgment primarily focuses on the amendment made to Section 65(12) of the Finance Act, 1994, by the Finance Act, 2007. The deletion of the words ‘but does not include cash management’ was the central point of contention. The Revenue argued that this deletion brought chit funds under the ambit of service tax, while the assessee argued that the deletion alone is not sufficient to include chit fund activities under service tax. The court held that the deletion of the words ‘but does not include cash management’ would not serve the purpose of the Revenue as it is necessary to show that the chit fund business is that of ‘asset management’ which it is not. The court also discussed the amendments made by the Finance Act, 2012, which introduced a negative list of services, and the Finance Act, 2015, which specifically included chit fund activities under service tax from June 15, 2015.

Development of Law

The ratio decidendi of this case is that chit fund activities do not fall under the definition of ‘banking and other financial services’ as defined in Section 65(12) of the Finance Act, 1994, even after the amendment made by the Finance Act, 2007. This judgment clarifies that the mere deletion of the exclusion of ‘cash management’ is not sufficient to bring chit funds under the ambit of service tax. The court also held that chit fund activities are not a form of ‘cash management’ or ‘fund management’. This ruling overturns the Kerala High Court’s judgment and reinforces the principle that taxing statutes must be interpreted strictly.

Conclusion

In summary, the Supreme Court dismissed the appeals filed by the Union of India, affirming the Andhra Pradesh High Court’s decision. The court held that chit fund activities are not subject to service tax under the category of ‘banking and other financial services’ for the period between June 1, 2007, and June 30, 2012. This judgment provides clarity on the interpretation of tax laws and the nature of chit fund operations, emphasizing the need for strict interpretation of taxing statutes and that the benefit of doubt should be given to the assessee.